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Takaful: A new and viable insurance business model or just a marketing opportunity?

July 7, 2008 at 6:45 pm · Filed under GCC, Life Takaful, Saudi Arabia, Takaful ·Tagged ,

Takaful: A new and viable insurance business model or just a marketing opportunity?

Cultural and religious reasons are commonly cited for the underdevelopment of insurance markets in the Gulf Cooperation Council (GCC) region.

Takaful could be the key to increasing insurance awareness and delivering on customer expectations, capitalizing on the positive economic dynamics of the region.

The opportunities for increased uptake of takaful insurance in the GCC are positive. The considerable economic growth in the region, coupled with a sizable, underinsured population, means that there are substantial prospects for further development of personal lines cover. The ability of the industry to demonstrate the need for and benefits of insurance, as well as to successfully meet customer demands, remains unproven, however.

Over time, if the world average insurance premium of $550 per capita is achieved and applied to the Gulf states, the GCC insurance market has a potential size of $20 billion(currently $4.6 billion). Taking as an example Malaysia, where the takaful market is expected to contribute 20% to the overall market in the medium term, the GCC takaful market has the potential to reach $4 billion at the current level of development (currently $170 million). How much actual premium the takaful sector generates and how quickly it will do so remains to be seen, however, and will depend on the industry’s ability to deliver on policyholder expectations.

In terms of credit ratings for the takaful sector, Standard & Poor’s Ratings Services will apply the same analytical process as for the traditional market, but will also take into account the sector’s positive growth dynamics and high execution risk.

GCC Insurance Markets

The insurance markets in the region are recognized as being underdeveloped, as is shown by the relatively low level of insurance penetration relative to Western or even Eastern Europe.

The economic boom in the GCC, driven by high oil prices, has led to substantial infrastructure investments across the region, with the corresponding need to insure these sizable risks. There are a number of established insurers in each of the GCC markets who are able capable of participating on the new risks arising. Certainly, the development of the non-life insurance market in the region is strong, with premium growth of about 10%-15% on average since 2004. The proportion of personal lines insurance cover, however, and in particular life insurance, remains low.

Opportunities For Takaful

Increasing insurance penetration, raising awareness

Takaful is not a new concept. The idea of cooperative risk sharing is the oldest form of insurance. The Grand Council of Islamic Scholars, Maja-al-Fiqh, only approved takaful as a Sharia-acceptable alternative to traditional insurance in 1985, however. The real opportunity for takaful in the longer term is substantial in our view, as it is able to reach the specific segments of the market that traditional insurance has been unable to attract.

Strong growth relative to traditional insurance market

The GCC takaful market is currently growing at about 40% per year, and gross contributions (equivalent to gross premiums written) amounted to nearly US$170 million in 2005.

This appears impressive relative to the expansion of the world markets, with average premium growth at 2.5% in 2005 (Swiss Re sigma No. 5/2006). It is, however, important to remember that this is a new segment of the market and growth at this level is not unexpected. At the same time, this growth is not purely driven by the personal lines market–one which we consider to be a natural market for takaful–but to a large extent also by general commercial lines. The main challenge for takaful still remains: to increase awareness of the benefits (social as well as individual) of insurance among retail customers. Still, the future success and sustainability of this pace of development will be dependent on a number of factors that, within personal lines, are just as relevant to the traditional as to the takaful regional markets.

The Success Factors

Product innovation and service quality

Although compulsory lines of business (motor and, in some cases, medical for expatriates) have driven much of the growth in the retail sector across the GCC, personal lines products are far from developed. This is as true of the traditional as of the takaful market. We view the recent announcements by international insurers that they will be entering the family takaful segment as positive, whether this is done as a joint venture with local companies, a greenfield operation, or through a branch.

The takaful market faces some unusual challenges. It has to match the service quality of the traditional insurance market and persuade an uninsured market to use the facilities of the takaful market. But across the Gulf region we are now seeing traditional insurers accept risks into new takaful divisions or subsidiaries of the mainstream company. Although the takaful division is operated as a wholly Sharia-compliant unit, it is fully complementary to the noncompliant business. If this model achieves the three key requirements of meeting Sharia council approval, being accepted by the Islamic community and policyholders, and passing regulatory requirements, the probable benefits of economies of scale to the traditional company will prove a real challenge to the nascent takaful sector. Each of the approaches has its own merits, but Standard & Poor’s is unable to comment on their relative Sharia compliance and acceptance in policyholders’ eyes.

The role of foreign insurers is also important, as they bring pockets of expertise in designing, for example, life products suited to local customers. This is gradually improving product choice, but the success of the takaful business model will depend on its ability to offer the same choice, range of products, level of cover, cost effectiveness, and, ultimately, quality of policyholder security, as traditional insurers. The challenge for takaful operators in developing family takaful will be to structure the products in such a way as to meet any religious and cultural obligations and still offer comprehensive cover.

In our opinion, it will also be crucial for takaful operators to demonstrate their ability to offer a comparable, if not better, level and quality of service than the traditional market when dealing with retail policyholders. The use of improved technology in automating processes (ease of buying a policy, speed of claims handling) to directly benefit the consumer will also benefit the takaful operators’ long-term competitive standing and prospects in the market.

Promotion and distribution capabilities

Even with the best products and service, future development will be constrained without the creation of demand and an increased awareness of the need for insurance. The onus still remains on the takaful operators to emphasize the broad appeal of Islamic insurance. In fact, takaful can be marketed as the ‘ethical’ alternative to insurance contracts due to its rigorous screening of investments. Additionally, in our view, expansion of independent financial adviser networks in all the Gulf states is essential. At the same time, some form of regulation is necessary to ensure adequate training of advisers and quality of advice to protect policyholders. The growth of Islamic finance, and in particular retail Islamic banking solutions including Islamic mortgages and credit cards, is certainly encouraging.

We also see bancassurance as providing the right additional distribution mechanism to reach the right retail customer. In the more established Malaysian takaful market, contributions from bancassurance constitute slightly more than 20% of all takaful contributions, second only to direct marketing (about 45%). In comparison, this distribution channel remains underutilized in the GCC, and generally contributes only a small amount to the overall contributions generated, as there are few bank-owned takaful operators.

Policyholder security, enterprise risk management, and profitability

Many family takaful contracts, and some general takaful contracts, will be more long-term in nature than the policies currently prevailing in the market (such as term life assurance or mortgage protection products). Therefore, the ability of a relatively new takaful operator to service claims and ensure policyholder security over the next 10-20 years is crucial. This is where a strong regulatory environment
comes into its own–to protect the policyholder and encourage healthy development of the industry, for both the traditional and the takaful segments. Specifically for takaful, the role of the Sharia board in overseeing the proper management of policyholder funds should help to increase transparency and improve corporate governance. Participants can increasingly benefit from the scrutiny of takaful operators by rating agencies such as Standard & Poor’s.

Generally, capitalization is strong given the underwriting risk base, and is expected to remain so for the medium term for both traditional and takaful insurance providers. Few insurers, however, have developed a more comprehensive, holistic approach to capital and risk management, and many appear to face high investment risk in their portfolios. Although traditional insurers currently have more investment opportunities open to them, they don’t always take them. In fact, a lot of the regional companies have a high percentage of equities in their investment portfolio. In the recent market corrections, companies have faced substantial volatility in earnings and shareholders’ funds, and have experienced reduced investment liquidity. There has been a high level of liquidity for policyholders’ funds, however, as cash deposits typically generously cover technical reserves. For takaful providers, as Islamic financial markets are developing rapidly, we expect that investment concentration risk, subject to management asset allocation choice, will be diversifiable in the medium term. Nevertheless, quantification of the risks undertaken throughout all operations, whether investments or underwriting, still requires development to ensure controlled earnings over time.

To date, takaful has not necessarily been the more profitable approach, as the general concept of mutualization of risks is applied. Average combined ratios have been higher than for traditional, regional peers.

Although the essence of takaful is cooperative risk sharing and community well being, rather than profit optimization, continued underwriting profitability will be important in order to invest in future growth. At the same time, takaful operators are currently suffering from a lack of economies of scale and an inability to more effectively diversify their risks. Hence, the management fees and contributions charged appear high in light of the true costs incurred by the operator. Although it is up to the individual Sharia boards to look more closely at this, we expect fees to decline and premiums charged to be more reflective of the level of cover provided as competition and scale in the takaful segment increase. The key benefit for policyholders over time, however, will be the distributable surplus more closely reflecting actual performance.

Source: http://www.ameinfo.com/116316.html
United Arab Emirates: Tuesday, April 10 – 2007 at 15:19

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Origins and Operations of Takaful System

April 13, 2008 at 8:34 pm · Filed under Islamic Insurance, Saudi Arabia, Shariah, Takaful ·Tagged , ,

Note: I’ve found this explanation on Takaful as one of the best and comprehensive from Takaful Taawuni website.

Origins and Operations of Takaful System

Background Elements to Takaful

Four fundamental factors must co-exist to establish the proper framework for a Takaful system:

A. Nea’a, or utmost sincerity of intention for knowingly following guidance and adhering to the rules of a Takaful system.

B. Integration of Shariah Conditions, namely: risk protection sharing under ta’awuni principle, coincidence of ownership, participation in management by policyholders, avoidance of Riba and prohibited investments, and inclusion of al Mudharabah or Wakalah principles for Takaful management.

C. Presence of Moral Values and Ethics, business is conducted openly in accordance with utmost good faith, honesty, full disclosure, truthfulness and fairness in all dealings.

D. No Unlawful Element that contravenes Shariah and strict adherence to Islamic rules for commercial contracts; namely the key elements present are:

* Parties have Legal Capacity (ie. +18 years old) and are mental fit

* Insurable Interest

* Principle of Indemnity prevails

* Payment of Premium is consideration (offer and acceptance)

* Mutual Consent (which includes voluntary purification)

* Specific Time Period of Policy and underlying Agreement

Main Objections against Conventional Insurance

While there a number of objectionable elements existing with conventional insurance, three main ones stand out.

Qard Al Hassan

According to Islamic principles, only one type of loan, Qard el Hasan (lit. good or benevolent loan) is allowable. Under the concept of Qard el Hassan, the lender may not charge interest or any premium above the actual loan amount. Some Muslim jurists state that this restriction includes directly or indirectly any benefits associated with the loan: “…this prohibition applies to any advantage or benefits that a lender might secure out of the qard (loan), such as riding the borrower’s mule, eating at his table, or even taking advantage of the shade of his wall.”

Muslims are encouraged to invest actively in ventures with an intent to share profits or losses that may result, rather than becoming a passive creditor. Unlike conventional commercial banking (largely based upon fixed, guaranteed rates of return-interest), this mutual sharing of risk promotes communal enterprises, risk-taking and productive activities. Monies are not sitting idle or invested at nominal, fixed rates of return. Instead, monies are applied to commercial transactions or agarian cultivation where risks and rates of return are balanced. A higher degree of risk in investment attracts a concomitant high rate of return to investors, provides stimulus to an economy and creates an environment for entrepreneurs to maximize their productive efforts.

By contrast, most conventional insurers invest premiums in bonds/loans (corporate and municipal) as well as other interest generating investments (involving Riba from Islamic perspective).

Riba (Interest/Premium/Usury)

The single most important aspect that differentiates Islamic finance from conventional finance and banking is the absence of interest. As discussed earlier, the Sharia prohibits both the taking and paying of interest (Riba) no matter what the purpose of the transaction, or the amount of interest charged. Apart from a minority interpretation of Sharia by a few Scholars, the consensus among Islamic jurists is that Riba and interest are the same.

There are four occasions in the Holy Quran where Riba is clearly prohibited. Refer to V.30:39; V.4:161; V.3:130 and V.2:275-276.

In the Yusuf Ali translation, Riba is described in commentary as “undue profit made, not in the way of legitimate trade, but out of loans of gold and silver, and necessary articles of food, such as wheat, barley, dates and sale…including profiteering of all kinds, but exclude economic credit, the creator of modern banking and finance…” He goes on to comment on the relationship of debitor-creditor in the four verses that follow: “…on behalf of debtors, as creditors are asked to (a) give up even claims arising out of past on account of usury, and (b) to give time for payment of capital if necessary, or (c) to write off the debt altogether as an act of charity.”

The use of Riba is clearly prohibited by Prophet Muhammed (PBUH) in a Hadith, where the Prophet (PBUH) condemned those who accept interest, as well as those who pay it or are witness to such a transaction.

Riba, however, circumscribes other aspects that makes commercial transactions suspect as well: “The Prophet (PBUH) forbade indeterminent, doubtful or speculative transactions or selling something before having possession of it.” “The Prophet (PBUH) forbade purchases from needy people and purchases involving uncertainty such as the sale of fruit before its maturity. “

Al Gharar (Uncertainty)

All commercial transactions must contain full disclosure. In other words, any transaction entered into should be free of uncertainty, deception and unknown elements or speculation. Al parties involved should have “full disclosure” or knowledge of the “counter values intended to be exchanged as a result” of the transaction, including the fact that “profits” cannot be guaranteed. The purpose of this prohibition is to avoid exploitation and injustice, especially on the part of the holder of capital.

Examples of prohibited transactions include: options, futures, derivatives, short sales and forward foreign exchange transactions (rates are determined by interest differentials). A number of transactions are treated as exceptions to the rule of Gharar. Such commercial transactions contain special treatments to assure they are organized to minimize harm and risk to both parties. Such transactions are:

1. Sales with payment in advance (bai’bithaman ajil)

2. Contract to manufacture (Istisna)

3. Hire contract (Ijara).

Specifically, Takaful transactions are design to minimize Al Gharar since the risk of future events can neither be known in advance nor influenced in any way. Note that the mere fact of purchase of a Takaful Contract in no manner affects future events nor does it guarantee that any specific outcome will/will not occur. Obviously, nothing in a Takaful operations can influence Al Qadar (Allah’s swt destiny).

Precedents for Islamic Insurance (Takaful)

An Islamic alternative to contemporary insurance is known as Takaful, and is based on the concept of Ta’awun, or mutual assistance. Ta’awun forms the basis of many Islamic practices. The teaching of Islam in regard to the equality and brotherhood of believers, and their responsibilities toward one another and all humanity led to several forms of mutual assistance both social and economic. Takaful as practiced in the sixth century (Christian Era A.D. and +50 Hijrah) actually evolved from tribal practices of mutual assistance dating back to pre Islamic times. There are several examples in pre-Islamic history whereby families, tribes or related members throughout the Arabia peninsula pooled their resources as a mean to help the needy on a voluntary and gratuitous basis. There practices were validated by Prophet Muhammed (PBUH) and incorporated into the institutions of the early Islamic State in Arabia around 650 C.E.

Examples of these early Islamic practices include the following:

* Merchants of Mecca formed funds to assist victims of natural disasters or hazards of trade journeys.

* Surety called daman khatr al-tariq was placed on traders against losses suffered during a journey due to hazards on trade routes.

* Assistance was provided to captives and the families of murder victims through a grouping known as a’qila.

* Contracts, called ‘aqd muwalat, were entered into for bringing about an end to mutual amity or revenge.

* Confederation were brought about by means of a hilf, or an agreements for mutual assistance among people.

Origins of Bloodrite in Islam

Before the time of the Prophet Muhammad (PBUH) , raids, looting, and traditions to revenge those killed were a common fact of nomadic Arab life. The hardships of desert life and a war-like vigilance forged a unity amongst groups wherein a group would act as a social unit .

In the words of Dr. M. Muslehuddin: “..not only does the unit consider the loss of its individual member as its own, it also takes steps to cover such loss, either by revenge and blood-letting, or alternatively by payment of blood money” by the group on behalf of the individual.” Such a perspective towards life and early society can be viewed as an early form of insurance (mutual self-protection).

The practice of blood money, or “wergild” was sustained for nearly a thousand years as a provision against danger to which a group of persons are all equally subject. A group united by blood-ties and family-ties comes to the aid of a member through mutual action. Hence, the custom of sharing in common. This practice was used for plundered property as well as compensation for the loss of life to avoid feud and unchecked destruction. The Arabic term for bloodtie is maaqil , which is derived from aql or aqila.

{Note: The vestiges of these practices still exist in Saudi Arabia today. Motorists who cause injury or death are obliged to pay a “wergild” to the victim’s family.}

During the emergence of Islam( 623-670 CE), some of these customs, including ‘aqila were sanctioned by the Prophet Muhammad (PBUH). In this way, these customs became part of the Sunnah (collection of sayings and practices of the Prophet Muhammad (PBUH) and subject to regulations by the Shari’ah.

The principle of maaqil was affirmed by the Prophet Muhammad (PBUH) as related in the following story from the Sunnah.

“Allah’s Apostle gave this verdict about two ladies of the Hudhail tribe who had fought each other and one of them had hit the other with a stone. The stone hit her abdomen and as she was pregnant, the blow killed the child in her womb. They both filed their case with the Prophet and he judged that the blood money was for what was in her womb. The guardian of the lady who was fined said,”O Allah’s apostle! Shall I be fined for a creature that has neither drunk nor eaten, neither spoke nor cried? A case like that should be nullified” On that the Prophet said, “This is one of the brothers of soothsayers.”

Two ladies (had a fight) and one of them hit the other with a stone on the abdomen and caused her to abort. The Prophet judged that the victim be given either a slave or a female slave (as blood-money). Narrated Ibn Shihab: Said bin Al-Musayyab said, “Allah’s apostle judged that in case of child killed in the womb of its mother, the offender should give the mother a slave or a female slave in recompense. The offender said, “How can I be fined for killing one who neither ate nor drank, neither spoke nor cried: a case like that should be denied.” On that Allah’s Apostle said “He is one of the brothers of the foretellers.” {Sahih Bukhari, Volume 7, Book 71, Number 654-655, Narrated by Abu Hurairah.}

The decree in this case was that the Prophet Muhammad (PBUH) decided that the second woman’s kin would pay a penalty to the relatives of the first woman who was killed (aqila), in accordance with established custom.

Mutual assistance amongst members of a tribe was not originally a commercial transaction and contained no profit or gain at the expense of others. Rather, it evolved as a social institution: to mitigate the burden of an individual by dividing it among his fellow members (group persons) or tribe. In contrast, most modern insurance (even mutual stock insurance entities, but not mutual associations) is a capitalist-based commercial enterprise, where losses are projected in advance and funds (premiums) allocated to risks to cover them. Premiums are paid in line with such projections of risk.

In short, the former practice involves compensation for actual losses upon occurrence by dividing them among the group, whereas, the latter involves the transfer of losses in advance based upon past experiences. This transfer often is from policyholders (the group) to shareholders (owner of insurance company) and thus voids the age-old principle of mutual assistance .

It is noteworthy that the first Constitution in Medinah (622 C.E.) arranged by Prophet Muhammad (PBUH) contained three aspects directly relating to insurance.

· Provision for social insurance affecting the Jews, Ansar and the Christians.

· Article 3 which included “the immigrants among the Quraish shall be responsible for their word and shall pay their blood money in mutual collaboration.”

· Provision for Fidya (ransom) whereby payment is made to rescue the life of a prisoner and the aqila (relatives) could cooperate to free him.

Takaful Referenced with the Qur’an and Sunnah

Although the word Takaful does not appear in the Holy Quran, it is derived from the term Ta’awun, or mutual assistance and connotes the same meaning. The second verse of Surah 5 in the Holy Quran exhorts the individual to assist others:

* “Assist one another in the doing of good and righteousness. Assist not one another in sin and transgression, but keep your duty to Allah” V.5:2.

In addition, many of the virtuous customs from the pre-Islamic period of Jahiliyya were declared “Islamic” by the Prophet Muhammad (PBUH) when he said: ” the virtues of the Jahiliyya are acted upon in Islam.” He further clarified this point in the constitution written in Medinah.

* They {Muslims of the Quraysh and Yathrib tribes} are one community (ummah) to exclusion of all men. The Quraysh emigrants according to their personal custom shall pay the blood-rite {aqila} within their number and shall redeem their prisoners with the kindness and justice common among believers.”

* Believers are to other believers like parts of a structure that tighten and reinforce each other.” Al-Bukhari and Muslim .

* The Believer, in their affection, mercy and sympathy towards each other, are like the body- if one of its organs suffers and complains, the entire body responds with insomnia and fever.” Muslim.

Given the Quranic admonition to “assist one another” and the words of the Prophet Muhammad (PBUH) regarding mutual assistance, Takaful may be understood as an imperative upon Muslim believers:

* “… a system based on solidarity, peace of mind and mutual protection which provides mutual financial and other forms of aid to Members {of the group} in case of specific need, whereby Members mutually agree to contribute monies to support this common goal.” O.Fisher

Finally, although a believing Muslim is required to accept (destiny or pre-ordainment) which can incorporate misfortune, s/he is not a passive “victim of circumstances. Conversely, the believing Muslim is exhorted by the injunctions of the Holy Quran to proactively take precautions in order to minimize potential misfortune, losses or injury from unfortunate events. One specific such instruction appears in Hadith to the owner of the camel to first tie your camel then rely upon the destiny ordained by Allah (swt).[Al Tirmidhi Vol.4,p.668].

A Perspective on Takaful from Islamic Scholars

The Majority viewpoint by contemporary Islamic scholars is that Takaful (cooperative insurance) is fully consistent with Shariah principles. This perspective is upheld by numerous meetings and resolutions :

* Council of Saudi Ulama (1397 Ah/1977 CE) resolution

* Fiqh Council of Muslim World League (1398/1978) resolution

* Fiqh council of Organization of Islamic Conference (1405/1985)

* Islamic Fiqh Week Conference, Damascus 1961

* Second Conference of Muslim Scholars, Cairo 1965

* Symposium on Islamic Jurisprudence, Libya 1972

* First International Conference on Islamic Economics, Meccah February 1976

* The Islamic Conference,Mekkah,October 1976

The esteemed shariah advisory Board of Bank Aljazira confirms also its viewpoint and whole heartedly endorsed the Family and Group Takaful Programs now offered by Bank Aljazira .{Refer to Fatwa dated April 2001}.

-THE END-

Source: http://www.takaful.com.sa/m1sub2.asp
(13 April 2008)

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